More firms seek SEC's OK as rating agencies

December 27, 2002|By From Tribune news services.

NEW YORK — The world of debt rating has belonged to three agencies for years, but that might change in 2003.

After a tumultuous year in the credit markets, the two top credit rating agencies, Moody's Investors Service and Standard & Poor's, have come under attack for missing red flags at companies such as Enron Corp. and WorldCom Inc. Their smaller competitor, Fitch Ratings, has become a target to a lesser extent.

That's nudged open the door to other firms hopeful of receiving the Securities and Exchange Commission's "Nationally Recognized Statistical Rating Organization" designation, a status the three largest agencies have enjoyed for more than 20 years.

Ratings issued by NRSROs are built into the infrastructure of the fixed-income markets in the form of investment guidelines for pensions, insurance companies, and bond and money-market funds.

"The rating agencies are fighting for their lives," said Frank Partnoy, a finance professor at the University of San Diego Law School and a former derivatives trader.

Critics such as Partnoy charge the rating agencies with ineptitude, complacency and conflicts of interest because they're compensated by issuers, not by investors.

Partnoy says NRSRO ratings are highly coveted not because they are backed by superior research but because they provide "the key that unlocks the gates to the financial markets."

Many firms are clamoring to get copies of those keys.

"The rating agencies failed miserably in warning investors on Enron, WorldCom and Genuity Inc.," said Sean Egan, co-founder of Egan-Jones Rating Co., which is seeking NRSRO status. "The SEC lists protecting investors as job No. 1, so it has to find ways to make ratings firms more responsive to investors."

Glen Grabelsky, managing director in Fitch Ratings' credit policy group, said that while the current system "works fine," the agency is "open to competition."

In testimony before the SEC in November, S&P President Leo O'Neill said the agency "believes that the marketplace benefits from a variety of credible sources of credit information" and called for more transparency in the NRSRO designation process.

When Moody's President Raymond McDaniel testified before the SEC, he said he is "neither in favor of nor opposed" to more competition, but warned that new entrants could try to compete for business by offering higher ratings.

The SEC held hearings in November as part of a broader study on the rating agencies mandated by passage of the Sarbanes-Oxley Act earlier this year.

Egan said there would be no risk of his agency currying favor with issuers because it is compensated by investors.

Egan-Jones also boasts a record that includes early and accurate calls on companies such as Enron and WorldCom.

It cut Enron's rating to junk on Oct. 26, while the other rating agencies waited until Nov. 28, four days before Enron filed for bankruptcy protection. Egan-Jones cut WorldCom to junk in July 2001, while Moody's and S&P waited until May of this year. It filed for bankruptcy in July.

Egan-Jones employs 10 analysts and rates approximately 800 issuers. That compares with about 700 analysts at Moody's, 1,250 at S&P, including equity analysts, and 720 at Fitch.

AM Best, which has a history of rating the finance strength of insurance companies, also has queued up at the SEC.

"We felt it was the right time in terms of the development AM Best has taken," said Larry Mayewski, executive vice president and chief rating officer, referring to the company's move to issue debt ratings as well as financial-strength ratings in 1999.

The company, which rates 500 securities for more than 150 issuers, employs about 500 people, including 125 analysts.